04/10/2013

Pensions safeguards on privatisation: will they survive the changes to state pensions?

Hardly a day seems to go by without a pensions-related story making the headlines.  While many of these stories relate to private sector pension issues, a good few column inches have been filled with the Government’s plans to provide a simpler, fairer state pension system.  This article looks at the Government’s plans for the new state pension and the issues they raise for utilities companies.

STATE PENSION CHANGES

There are currently two parts to state pension provision: the basic state pension and the state second pension.  The basic state pension is a flat rate pension.  The state second pension is based on an employee’s earnings between the lower and the upper earnings limit.

Many occupational pension schemes (including the utilities pension schemes) are “contracted-out” of the state second pension.  This means that, where the statutory conditions are satisfied, the state second pension benefits are provided from the scheme instead of by the Government.  In return for providing those benefits from the scheme, both the employee and the employer pay reduced National Insurance Contributions.   Currently the National Insurance Contribution rebate is 3.4% for employers and 1.4% for employees.

From 6 April 2016 both the basic state pension and the state second pension will be replaced by the single tier pension.  In today’s prices the single tier pension will be £144 per week although the exact figure will be finalised shortly before implementation.

WHAT THE CHANGES MEAN FOR CONTRACTED-OUT PENSION SCHEMES IN GENERAL

The Government confirmed in its January 2013 White Paper that integral to the single tier pension reforms is the abolition of occupational pension scheme contracting-out.  It is important to note that contracted-out benefits which have accrued up to 6 April 2016 will be protected and must still be paid.

The end of contracting-out will, however, have a cost implication for both employees and employers.  The National Insurance Contribution rebate will no longer apply with the consequence that employee National Insurance Contributions will increase by 1.4% and the employer National Insurance Contributions by 3.4%.

The Government has acknowledged that employers may wish to change the design of their pension scheme in order to offset this increased cost.  The Pensions Bill 2013 contains an overriding modification power which will allow an employer, for a limited period of time and without trustee consent, to amend future service pension benefits to “the extent that they offset the cost of additional employer National Insurance Contributions” or to increase member contributions.

WHAT THE CHANGES MEAN FOR UTILITIES COMPANIES

When the utilities industries were privatised, protections in respect of pensions for employees in service on privatisation were agreed.  The exact level of protection differs across the electricity, gas, coal and water industries.  A common feature across all these protections, however, is that pension benefits for scheme members on privatisation can only be changed in limited circumstances.

The protections for the coal and electricity industries are set out in the relevant Protected Persons Regulations.  Broadly speaking these Regulations require pension benefits for employees who were employed at the time of privatisation to be at least as good as those they received before privatisation.  The Regulations also prevent amendments being made to the scheme which reduce future accrual or increase contributions for those employees.

The protections for the water and gas industries are not set out in regulations but are instead contained in the relevant pension scheme rules.  In the case of the water industry, protected pension benefits are subject to a discretionary trustee veto in relation to any changes to benefits.  It is worth remembering that those pension benefits were provided by the Local Government Pension Scheme before privatisation in 1989.  The gas schemes contain a restriction whereby any reduction in scheme benefits or increase in member contributions can only occur with the consent of two thirds of affected members.

The utilities companies have been lobbying the Government in relation to the end of pensions contracting-out.  They have been particularly concerned to ensure that the Pensions Bill modification power will allow them to treat all employees (particularly those covered by the Protected Persons Regulations) in the same way for pensions purposes. The companies consider that any difference in treatment is both unfair and will have serious negative implications for industrial relations.

The Government has taken on board industry concerns.  In January 2013 it issued a consultation paper looking at whether or not utilities companies with employees subject to the Protected Persons Regulations should be able to use the modification power in the Pensions Bill to amend pension benefits and/or member contributions to the extent needed to offset the employer National Insurance Contributions increase.  As an overriding principle the paper makes it clear that the Government is keen to balance the rights and expectations of both affected employers and employees.  The consultation closed on 14 March 2013.  The Government’s response to the consultation has not yet been published.

It is important to note that the consultation does not deal with the water and gas industries with pensions protections set out in scheme rules.  Presumably the Government considers that those schemes will be able to take advantage of the Pensions Bill power.

It will be interesting to see what the Government’s response to the consultation will be.  The consultation responses that are available fall into two categories.  The National Association of Pension Funds has said that applying the statutory modification power across the board to all private sector pension schemes is the fairest and most appropriate approach.  The Protected Persons Regulations were introduced against the background of the current state pension system and did not envisage the end of contracting-out.

In contrast UNISON considers that the statutory power should not be extended to Protected Persons.  The union notes that only a relatively small number of people are covered by the Protected Persons Regulations and most of those individuals are nearing retirement.  It considers that affected individuals should be treated the same as members of public sector schemes who will not face any pension scheme changes arising from the abolition of contracting-out.

IN CONCLUSION

The Government’s consultation response will be eagerly awaited by both the utilities companies and the unions.  It is likely that whatever the Government concludes, this is an issue which will be subject to continued debate.

To find out more, please contact Terry Saeedi, partner and head of Pensions at Gordons LLP on 0113 227 0333 or at terry.saeedi@gordonsllp.com.